You have no doubt heard the well-worn dictum of Karl Von Clausewitz, the great Prussian military strategist, that war is the extension of politics by other means. Well, the same is true of economic policy. As often as not, it's politics by other means—and the looming debate over whether the country needs an "economic stimulus" program will, if nothing else, reaffirm that. The debate promises to be more about politics and public relations than economics. "Economic stimulus" is shorthand for tax cuts and/or increases in government spending designed to accelerate economic growth and job creation. We need that now, say advocates, because the economy is on the verge of a recession or already in one. House Democrats are reportedly discussing a package of $100 billion or more in temporary tax rebates and grants to states. Not to be outdone, the Bush administration is studying tax rebates and business investment incentives.
Call this Lollipop Economics. It's an election year. Voters feel anxious about a weakening economy. Send them economic lollipops (say, a $500 tax rebate for most families). Make them feel better. Show them you're concerned. Prove that you're trying to improve the economy. Above all, make sure they know where the lollipops came from—Democrats or Republicans. Inevitably, presidential candidates offer proposals.
Superficially, the case for "stimulus" seems plausible. In December, the unemployment rate rose from 4.7 percent to 5 percent, a huge one-month increase. Jobs are not now keeping pace with the growth of the labor force. The December increase in payroll employment was a meager 18,000, and all that stemmed from government jobs. The economy needs a shove. Lawrence Summers, Treasury secretary in the Clinton administration, has proposed a $50 billion to $75 billion stimulus to be enacted in the next few months.
Every day, the housing situation seems to worsen. Last week Countrywide Financial—the nation's largest mortgage lender—reported that new foreclosures were higher than expected. Jared Bernstein of the Economic Policy Institute, a liberal think tank, likens a stimulus package to insurance. "The important part," he says, "is to prevent a bad situation from getting worse." Bernstein worries that Federal Reserve policy alone—cuts in short-term interest rates—won't suffice to spur the economy.
All this sounds sensible, but it ignores a confounding dilemma. Folks, we have a $14 trillion economy. A one-time stimulus (rebates aren't permanent tax cuts, and grants to states would probably be temporary) of $75 billion or $100 billion is too small to do much. If the economy is in serious trouble, something much larger is needed. But if the outlook is not so dire, then a modest stimulus plan is mostly political symbolism.
The truth is that there's a touch of hysteria to much current economic commentary that is, as yet, unjustified by what's actually happened to the economy. Yes, the housing slump is vicious, but at its peak, housing was only 5.5 percent of the economy, and the present slump is still only the fourth worst since World War II, notes economist Edward Leamer, director of the UCLA Anderson Forecast.
Whether a recession occurs—a determination made by academic economists, usually after the fact—probably won't affect most people. Differences in forecasts are fairly small. Economist Richard Berner of Morgan Stanley expects a "mild and short" recession, with peak unemployment of 5.6 percent or 5.7 percent in early 2009. Economist David Wyss of Standard & Poor's anticipates slower growth, but no recession; he, too, foresees peak unemployment of 5.6 percent. That's the average, he says, of the past 50 years. This would be a setback, but not a disaster.
Only time and patience will cure some economic problems. Though few mention it, rising inflation is a threat. For the year ending in November, consumer prices increased 4.3 percent; the annual rate for the past three months is 5.6 percent. Raw material prices have soared. In early 2006, copper sold for $4,900 a metric ton, reports economist John Mothersole of Global Insight. By late 2007, the price was $7,300. Slower economic growth—even a recession—would dampen prices and incipient inflationary psychology.
The housing predicament is similar. Inventories of unsold homes are high; monthly sales are low. What basic economics teaches is that when there's a big gap between supply and demand, prices adjust. That has to happen in housing. Home prices must drop further, so that houses become more affordable and revive both sales and new construction. It's true that falling home prices will probably lead to more mortgage losses and foreclosures. But the more the adjustment is delayed, the longer the housing market will remain moribund.
In an election year, politicians inevitably try to show their sensitivity to voters' economic worries. A slowing economy does suggest a few common-sense and responsible steps: for instance, lengthening unemployment benefits from the standard 26 weeks to 39 weeks. But a big exercise in pump-priming, which is all that a "stimulus" package is, would be justified only if the economy deteriorated considerably more.
It's not possible, or desirable, to correct every twist in the business cycle. A "stimulus package" now would represent the use of government funds for campaign advertising—to show voters how "caring" their politicians are. The great danger is that once proposed in a modest lollipop form, any plan would quickly be expanded to include many other tax breaks and spending increases, the fiscal equivalents of candy bars and peppermint sticks. This would bloat its costs and confuse the public about the long-term budget problem, which is, not surprisingly, just the opposite: to control the huge spending increases of baby boomers' retirement.